Labour/Employee Cost

Classification of Labor Cost

Labour cost may be broadly classified as direct labour cost and indirect labour cost.

Direct Labour Cost: Labour cost that is expended in production of a product and easily identified and
allocated to a cost unit i.e. a specific job, contract, work order or any other unit of cost.

Indirect Labour Cost: Labour cost that is expended on the wages of workmen who are not directly
engaged in the production process and cannot be easily identified with a cost unit.

Distinction between Direct and Indirect Labour Cost:

Direct labour cost Indirect labour cost
1. It is the cost incurred in payment of labour who 1. Cost incurred for payment of labour who are
are directly engaged in the production process not directly engaged in the production process.
2. Direct labour cost can be easily identified and 2. Indirect labour cost is apportioned on some
allocated to cost unit.. appropriate basis.
3. Direct labour cost varies with the volume of 3. Indirect labour cost may not vary with the
production and has positive relationship with the volume of production.
volume.

Labour Cost Control

 Labour cost control means control over the cost incurred on labour.
 Labour costs are associated with human beings.
 To control labour costs one has to understand human behavior; why human being works and
what factor motivate them to give best performance.
 Control over labour costs does not imply control over the size of the wage bill; it also does
not imply that wages of each worker should be kept as low as possible.
 The aim should be to keep the wages cost per unit of output as low as possible, but not to
under paid or unpaid the workers. This can only be brought about by giving workers optimum
wages and then harnessing their energies to optimise output.
 A well motivated team of workers can bring about wonders. Each concern should, therefore,
constantly strive to raise the productivity of labour.
 The efforts for the control of labour costs should begin from the very beginning. There has to
be a combined effort by all the concerned departments. In a large organisation, generally the
following departments are involved in the control of labour costs:
Department Functions
1. Personnel Department i) On receipt of labour requisition from the various departments it
/Human Resource searches for the required skills and qualification.
Department/ People’s ii) It ensures that the persons recruited posses the requisite
Department qualification and skills required for the job.
iii) Arranges proper training for the newly recruited workers and
workshops for existing workers.
iv) Maintains all personal and job related records of the employees.
v) Evaluation of performance from time to time
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 2. Engineering and i) Prepares plans and specifications for each job
Work Study Department ii) Providing training and guidance to the employees
iii) Supervises production activities
iv) Conducts time and motion studies
v) Undertakes job analysis.
3. Time-keeping vi)
This Conducts
Departmentjob is
evaluation.
primarily concerned with the maintenance of
Department attendance records of the em- ployees and the time spent by them on
various jobs, etc. X---------9AM-7PM=
4. Payroll Department i) The preparation of payroll of the employees.
ii) It disburses salary and wage payments.
5. Cost This department is responsible for the accumulation and classification
Accounting etc. of all type of costs.
Department All such data pertaining to labour costs are also collected, analysed and
allocated to various jobs, processes, departments, etc., by this
department.

Important Factors for the Control of Labour Cost:

To exercise an effective control over the labour costs, the essential requisite is efficient utilisation of
labour and allied factors. The main points which need consideration for controlling labour costs are the
following:
(i) Assessment of manpower requirements: in terms of numbers and skills
(ii) Control over time-keeping and time-booking. In 9AM- Out 7PM – Job A-4
hours and Job B-3 hours
(iii) Control over idle time and overtime.
(iv) Control over labour turnover.
(v) Control over casual, contract and other workers.

(VI) Time & Motion Study.

(VII) Job Evaluation and Merit Rating.
(VIII) Wage and Incentives systems
(IX) Labour productivity.

Control over time-keeping and time-booking.

Timekeeping: It refers to correct recording of the employees’ attendance time. Correct recording
of employees’ attendance time is of utmost importance where payment is made on the basis of
time worked.
In fact the various objectives of time-keeping are as follows:
-For the preparation of payrolls.
-For calculating overtime.
-For ascertaining and controlling labour cost.

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 -For ascertaining idle time.
- For disciplinary purposes. - For overhead distribution.

Methods of Time Keeping: Attendance Register Method, Metal Disc Method, Time Recording
Clocks, Dial Time Records, Punch Card attendance system, Bio Metric Attendance System.

Time-Booking – Actual time spend for job by the workers out of time available form time keeping.
Time keeping has two parts as time booking and idle time. Different job time card is used for record of
time actually booked for a job.
Time Keeping; In 9AM-out 6PM= 9 hours
Time Booking: Job A=4
Job B=4
Idle Time=1

Control over idle time and overtime.

Idle Time: Time worker remained Idle/ was kept waiting for one reason or another due to lack of work,
lack of material and supplies, lack of instructions, machine breakdowns, power failures and the like. These are
all vital pieces of information necessary for the proper collection of cost data and for effective controlling of
costs. For the collection of all such information, a separate record, generally known as Time (or Job) card, is
kept.
Normal Idle Time: It is the time which cannot be avoided or reduced in the normal course of business.
Cost of Normal Idle time to be absorbed by good units produced through direct labour cost-for direct worker
and overheads-for indirect worker

Abnormal Idle Time: Apart from normal idle time, there may be factors which give rise to abnormal
idle time. Cost of abnormal Idle time to be charged to Costing P/L A/C

Overtime: Work done beyond normal working hours is known as ‘overtime work’. Overtime payment is
the amount of wages paid for working beyond normal working hours. The rate for overtime work is higher
than the normal time rate; usually it is at 1.5 times of the normal rates. The extra amount so paid over
the normal rate is called overtime premium.

As per the labour Act 2074, Where a worker works in a factory for more than eight hours in any day
and for more than fortyeight hours in any week, he shall, in respect of overtime work, be entitled to wages
at the rate of 1.5 times his ordinary rate of wages.”

In excess of 8 hours per day and 48 hours per week-Overtime- rate 1.5 times

As per the Factories Act 1948 (India) “ Where a worker works in a factory for more than nine hours
in any day or for more than fortyeight hours in any week, he shall, in respect of overtime work, be
entitled to wages at the rate of twice his ordinary rate of wages.”

In excess of 9 hours per day or 48 hours per week-Overtime- rate 2 times

Ordinary rate of wages means the basic wages plus regular allowances, including the cash equivalent
of the advantage accruing through the concessional sale to workers of food grains and other articles,
as the worker is for the time being entitled to, but does not include any facilities and bonus in
wages for overtime work.

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X worked overtime 5 hours and his normal rate of payment is Rs. 100 per hour
Wages for overtime; total 5 hours*150= 750
Normal wages= 5 hours * Rs. 100= 500
OT Premium= 5 hours*Rs. 50= 250

Causes overtime and treatment of overtime premium in cost accounting

Treatment
1. If overtime is resorted at the desire of the customer, then overtime premium may be charged to the job
directly.

2. Overtime as policy of company to meet shortage labour hour: Overtime premium is to be treated as labour
cost. Inflated labour rate can be used to charge labour cost for the jobs.

Required labour hour 500,000 hours and available labour hour is only 400,000 hrs. The company has
policy to meet shortfall labour hour working overtime. Normal labour rate is Rs. 50 per hour.
Wages for normal hour= 400000*50= 20,000,000
Wages for overtime hour= 100000*50*1.5= 7,500,000
Total 27,500,000
Inflated labour rate=27500000/500000= Rs. 55

3. If overtime is required to cope with general production programmes or for meeting urgent orders: the
overtime premium should be treated as overhead cost of the particular department or cost centre which
works overtime.

4. If overtime is worked in a department due to the fault of another department: the overtime premium
should be charged to the latter (fault making) department.

5. Overtime worked on account of abnormal conditions such as flood, earthquake etc., OT premium
should not be charged to cost, but to Costing Profit and Loss Account.

Control over labour turnover.

Labour turnover in an organisation is the rate of change in the composition of labour force during a
specified period measured against a suitable index. The standard of usual labour turnover in the industry
or locality or the labour turnover rate for a past period may be taken as the index or norm against
which actual turnover rate is compared.
There are three methods of calculating labour turnover which are given below:

(i) Replacement Method: This method takes into consideration actual replacement of labour
irrespective of number of persons leaving

Number of employees replaced during the period

× 100
Average number of employees on roll
New labour appointed on account of expansion not to be included in number of replacements.

(ii) Separation method: In this method labour turnover is measured by dividing the total
number of separations during the period by the average total number of workers on

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 Number of employees separated during the period *
= 100
Average number of employees on roll during the period

(iii) Flux method: This method takes into account both the number of replacements as well
as the number of separations during the period
Number of employees ( separated +replaced) during the period
= × 100
Average number of employees on roll during the period

Labour turnover due to new recruitment: Workers joining a business concern on account of
its expansion do not account for labour turnover. But these newly recruited workers are certainly
responsible for a change in the composition of labour force, due to this feature, some cost
accountants measure workers to the extent of new (excluding replacements) joining the labour
force as follows :
No. of new workers joining in a period (excluding replacements)
= × 100
Average number of workers on the roll in a period
Labour Accession: Number of total workers joined during the period including new
recruitment are called labour accession. When labour accession given in the questions, labour
turnover under replacement has to be calculated as follows:
No. of workers joining in a period (including replacements)
= × 100
Average number of workers on the roll in a period

Effects of Labour Turnover: High labour turnover increases the cost of production in the
following ways:
(i) Even flow of production is disturbed; Loss of production and contribution form the same
(ii) Generally, efficiency of new workers is low; productivity of new but experienced
workers is low in the beginning;
(iii) There is increased cost of training and induction;
(iv) New workers cause increased breakage of tools, wastage of materials, etc.
In some companies, the labour turnover rates are as high as 100%; it means that on the average,
all the work is being done by new and inexperienced workers. This is bound to reduce
efficiency and production and increases the cost of production.
(v) Cost of recruitment and training increases.

Two types of costs which are associated with labour turnover are:
(a) Preventive costs: These include costs incurred to keep the labour turnover at a low
level, i.e. cost of medical services, housing scheme, Development plans, educations opportunity,
transportation or vehicle service, welfare schemes and pension schemes. If a company incurs
high preventive costs, the rate of labour turnover is usually low.
(b) Replacement costs: These are the costs which arise due to high labour turnover. If
person leave soon after they acquire the necessary training and experience of good work, additional
costs will have to be incurred on new workers, i.e., cost of employment, training and induction,
abnormal breakage and scrap and extra wages and overheads due to the inefficiency of new

CA. KISHOR PRASAD BIMALI 5

 workers.
It is obvious that a company will incur very high replacement costs if the rate of labour
turnover is high. Similarly, only adequate preventive costs can keep labour turnover at a low level.
Each company must, therefore, work out the optimum level of labour turnover keeping in view its
personnel policies and the behaviour of replacement cost and preventive costs at various levels
of labour turnover rates.
Remedial Steps To Minimise Labour Turnover - The following steps are useful for
minimising labour turnover.
1. Exit interview : An interview be arranged with each outgoing employee to ascertain the
reasons of his leaving the organisation.
2. Job analysis and evaluation : Before recruiting workers, job analysis and evaluation
may be carried out to ascertain the requirements of each job.

3. Scientific system of recruitment, placement and promotion: The organisation should make
use of a scientific system of recruitment, selection, placement and promotion for employees.
4. Enlightened attitude of management: The management should introduce the following
steps for creating a healthy working atmosphere :
(i) Service rules should be framed, discussed and approved among management and
workers, before their implementation.
(ii) Provide facilities for education and training of workers.
(iii) Introduce a procedure for settling worker’s grievances.
6. Use of committee: Issues like control over workers, handling their grievances etc., may be dealt by
a committee, comprising of members from management and workers.

Time & Motion Study

 Time study is defined as a work measurement technique for recording the time and rates of working for
the elements of a specified job carried out under specified conditions, and for analyzing the data so as to
obtain the time necessary for carrying out the job at a defined level of performance.
 Thus time study attempts to ascertain the time spent on each element of a job. The sum total of the time
taken by all elements of a job is called the standard time. This standard time is the total time which should
be taken by a person of average ability to perform a job under standard conditions.
 Motion study involves a detailed study and analysis of the basic operations of a job or process or workers
movement while performing job with the object of eliminating unnecessary ones.
 Motion Study is closely associated with operations analysis. Operations analysis is a primary analysis
which aims at eliminating major deficiencies.
 Motion Study is a secondary analysis which aims at refining the methods and operations to achieve
further improvements and in addition it attempts to study the movements of human limbs as well as the
mechanical set up and operations.

In brief, the time study aims at determining the standard time for a job and motion study aims at the elimination
of unnecessary motions or the movements performed by the workers on the job. Time and motion study are
infact complementary to each other. The main steps involved in setting standard time for a job/operation under
time study are as follows:
(i) Collect and record all the information available about the job, the operator and the surrounding
conditions, which may affect the carrying out of the work.
(ii) Observe and record a complete description of the method and the operations necessary for

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 performing the job. Further break down each of the operations performed for carrying out the job
into its elements/parts.
(iii) Examine each operation and its elements thoroughly to ensure that the motions used to perform are
most effective.
(iv) Measure and record by using a stop watch the time taken by different operators to perform each
element of an operation. Enough such observations be taken to determine the average time of these
observations. The average time is also known as normal or base time for each element. Sum the
base time of each element to arrive at the base time of an operation.
(v) Determine the allowance for relaxation etc., to be made over and above the base time for the
operation.
(vi) The standard time of an operation is obtained by adding the base time with the allowance made.
Time and Motion study is quite useful to management:
(a) It helps the management to assess correctly the labour requirements.
(b) It helps management in the fixation of wage rates and introduction of effective incentive
schemes.
(c) It helps management in standardizing jobs, equipments and methods by giving guidance as to
the best method of operating in the time set.
(d) It helps the management to improve on work methods by comparing time taken to complete the
same type of work under different methods.
(e) It helps management in planning and exercising cost control.

Job evaluation and Merit Rating

 Job evaluation can be defined as the process of analysis and assessment of jobs to ascertain
reliably their relative worth and to provide management with a reasonably sound basis for
determining the basic internal wage and salary structure for the various job positions.
 In other words, job evaluation provides a rationale for differential wages and salaries for
different groups of employees and ensures that these differentials are consistent and equitable.
 Merit rating is the quantitative or qualitative assessment of an employee’s personality or his
performance on the job made by his supervisor or other persons qualified to judge.
 Points of distinction between job evaluation and merit rating: The main points of distinction
between job evaluation and merit rating are as follows:
1. Job evaluation is the assessment of the relative worth of jobs within a company and merit
rating is the assessment of the relative worth of the man behind a job. In other words, merit
rating rates employees on their job while jobs evaluation rates the jobs.
2. Job evaluation and its accomplishments are meant to set up a rational wage and salary
structure whereas merit rating provide a scientific basis for determining fair wages for each
workers based on his ability and performance.
3. Job evaluation simplifies wage administration by bringing a uniformity in wage rates. On
the other hand, merit rating is used to determine fair rate of pay for different workers on
the basis of their performance.

Methods of job Evaluation: Methods of job evaluation can be classified into three major groups as
below:
1. The Ranking and Grading Method. 2. The Point Rating Method. 3. The Factor Comparison Method

Salary Structure
GM-200000 PM

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CFO-150000 PM
Marketing Deptt Head-150000 PM
Prodn Manager- 100000 PM
Officer-50000 55000 50000 45000 52000
Supervisor-40000
Worker- 20000

Systems of Wage Payment and Incentives

Principles
Payment By Time
Payment By result

Systems
1. Time Rate System: Earnings = Hours worked × Rate per hour
2. Straight Piece Rate system: Earnings = Number of units produced × Piece rate per unit

3. Taylor’s Differential Piece Rate System

F.W. Taylor’s System

Efficiency Payment
Less than 100%
Efficiency 83% of the normal piece rate or 80% of piece rate
when below standard
Either 100% or 125% of the normal piece rate or 120% of piece rate
more than 100% when at or above standard

4. Merrick Differential Piece Rate System

Efficiency Payment
Up to 83 % Ordinary/ Normal piece rate
83% to 100% 110% of ordinary piece rate (10% above the ordinary piece rate)
Above 100% 120% or 130% of ordinary piece rate (20% to 30% of ordinary piece
rate)

5. Gantt Task and Bonus System

Output Payment
Output below standard Guaranteed time rate (GTR)
Output at standard 120% of time rate (GTR)
Output above standard High piece rate or 120% of Piece Rate

6. Emerson Efficiency System

Earning is calculated as follows:
Efficiency Payment
Below 66-2/3% Guaranteed time rate only.
66-2/3% to 100% Time Rate +Bonus up to 20% of time rate (for performance in between
66.67% to 100%)

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 Above 100% 120% of time wage rate plus additional bonus of 1% for each 1%
increase in efficiency above 100%.
Example:
If the efficiency is 80%, bonus % will be= 20%/(100%-66.67%)*(80%-66.67%)= 8%
If efficiency is 115%, bonus % will be= 20%+15%=35%

7. Premium Plans
Halsey Premium Plan
Earnings= (Time Rate* Actual Hours) + (½* Time Saved* Time Rate)

Basic wages Premium/bonus

Rowan Premium Plan

Earnings= (Time Rate* Actual Hours) + (Time taken/Time allowed* Time Saved* Time
Rate)

Example:
Standard time Allowed= 8 hours
Wages rate per hour= Rs. 10
Actual time taken: 1 to 7 hours

Time Taken Time Saved Basic Bonus Total Wages

In hours In Hours Wages Halsey Rowan
1 8-1=7 1*10=10 (½*7*10)=35 1/8*7*10=8.75
2 8-2=6 2*10=20 ½*6*10=30 2/8*6*10=15
3 8-3=5 3*10=30 ½*5*10=25 3/8*5*10=18.75
4 8-4=4 4*10=40 ½*4*10=20 4/8*4*10=20 Bonus under
Rowan is
maximum
5 8-5=3 5*10=50 ½*3*10=15 5/8*3*10=18.75
6 8-6=2 6*10=60 ½*2*10=10 6/8*2*10=15
7 8-7=1 7*10=70 ½*1*10=5 7/8*1*10=8.75

*Maximum bonus under Rowan plan will at point where time taken is half of time allowed.
* Bonus under Halsey and Rowan plan will be equal at point where time taken is half of time
allowed.
*Rowan plan restrict the speed of worker up to double of normal by reducing bonus. It means
Rowan plan is more focus in the quality of the product.
*Rowan plan will safeguard company in case error in time setting by the responsible deptt.

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